Opinion: Small businesses and entrepreneurs are outmatched by larger rivals

WASHINGTON (MarketWatch) — The same winner-take-all forces that spawned superstar salaries and extreme inequality of wealth are also helping large, established businesses stifle our economy by capturing an ever-larger market share from smaller and newer companies.

This corporate inequality is beneficial in some respects, and toxic in others.

On the positive side, big businesses are more productive than small ones, they pay higher wages, they are more profitable, and they are better positioned to compete in the globalized economy.

Unfortunately, large, established businesses don’t create many jobs, and they aren’t very innovative. And right now, our economy desperately needs more jobs and innovation.

New companies provide most of the net job creation in the United States. Startups also challenge the old guard by introducing new products, new services and new methods. Sometimes they even invent new markets. Startups are the most dynamic part of the most dynamic economy in the world.

Unfortunately, the U.S. economy seems to be losing its mojo. Fewer new companies are being formed. The startup rate has been dropping since the 1970s, and the number of startups is down about 27% since 2006.

If startups were creating jobs at the same rate they were in the first half of the previous decade, we’d have 3 million more jobs.

As Ian Hathaway and Robert Litan put it in a recent paper for the Brookings Institution, “A dynamic economy constantly forces labor and capital to be put to better uses, but recent evidence points to a U.S. economy that has steadily become less dynamic over time.”

There’s one other factor that I think is underappreciated: The old guard has gotten the upper hand. As the number of startups has fallen over the past few years, older and larger companies are dominating the economy like never before.

Wall Street is killing Main Street.

Most sectors of the economy are dominated by larger and older firms, who use their competitive advantages to stifle innovation by smaller and younger rivals. There’s always been a battle between the old and the new, but lately it seems the old is winning. Larger companies are increasing their market share, so that most sectors of the economy are becoming more concentrated.

Everybody knows that some sectors — banking, auto manufacturing, media, big-box stores — are dominated by just a few companies. But it may be surprising to learn that dozens of other sectors — from courier services to paper mills to grocery stores — are also dominated by a few large firms. In most of the economy, any given market is likely to be controlled by the 20 largest companies in that segment.

A new rival that has a truly innovative idea can break into the top 20, just as Wal-Mart
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Starbucks
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Amazon
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Southwest Airlines
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and Apple
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did. But most startups don’t have an innovative idea, and most of them stay very small or they get crushed.

How do the large companies crush their rivals? By using the advantages of their size.

Large companies enjoy economies of scale, which means they can produce at a lower cost than a smaller company. Larger companies operate at a bigger scale, which means their businesses are more diversified than a startup’s.

Large companies also take advantage of customer captivity (or, depending on your point of view, customer loyalty). It can be costly for a customer to switch to a competitor. Shopping around takes time and money. We’re loyal to Amazon or Starbucks or Apple because we’ve gotten comfortable with them. It’s part of our routine. We know how they do business, and we’ve grown to trust them. We’d have to start all over again with someone new.

Large companies also have valuable things that newer companies don’t have. Sometimes they have exclusive licenses to operate in a market or a government subsidy or a contract. They often have patents that prevent their rivals from competing. Maybe they’ve locked up some crucial resource.

Some large companies stay powerful because of network effects. Facebook’s
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biggest asset is its base of more than a billion users. We can’t switch easily, because our friends are on Facebook, not on some other social media site. That doesn’t mean Facebook could never be replaced; it just means that any rival has to offer us something much better.

Some large companies keep the competition at bay by buying out anyone who threatens them, and then quietly killing their innovative ideas.

Finally, many large companies are protected by nearly insurmountable barriers to entry. Even if you invent a better mousetrap, you’ve still got to make it and sell it, and that can cost billions.

Most of the time, big companies get bigger in perfectly legal ways. They aren’t being unfair. It’s just the market working its magic.

The winner-take-all society doesn’t just describe CEOs, movie stars or top athletes. It also applies to the corporate world, where the rich get richer, and the opportunities to rise up from the bottom are quickly disappearing.

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